As global central banks have entered rate-hiking cycles, the negative impacts of rising interest rates are becoming apparent. Entering October, not only have long-term U.S. Treasury yields remained high, European sovereign debt has also faced a tendency to be sold off, with European sovereign bond yields continuing to climb. On October 7, the yield on the 10-year French government bond rose by more than 0.1 percentage points, touching 4.93% at one point, while the yield spread between French and German bonds rebounded to 140 basis points. In early October, the spread between 10-year French and German government bonds briefly broke through 150 basis points, hitting a new high since the European debt crisis of 2011. The yield on the 10-year French government bond approached 5% during trading, with its financing costs already exceeding those of Italy and Greece. Italy, formerly one of the PIGS nations of the European debt crisis, saw its 10-year government bond yield drop to as low as 4.7% at times since October, rebounding to 4.623% on the 7th, while the Italian-German yield spread rose to around 129 basis points.

As part of the eurozone's troika, Germany's government bonds have also shown an upward trend this year. Amid European Central Bank (ECB) rate hikes and the Middle East energy crisis, the 10-year yield rose to 3.631% in late September, the highest since mid-2009. Since October, it has hovered in the 3.4% to 3.5% range, and on October 7 the yield on the 10-year German government bond was about 3.471%. The British bond market has not been spared either. The yield on the 30-year British government bond rose as high as 6.04% intraday, reaching a new high since 1998, before retreating slightly to just below 6%. The yield on the 10-year British government bond rose by 6.8 basis points to 5.442%. On October 8, the yield briefly rose to about 5.50% during trading, approaching its highest level since 2007. Similar to the situation in the U.S., the falling prices of sovereign bonds in major European economies are closely related to mounting global inflation. Meanwhile, under the U.S.-Iran conflict, high energy prices have had a greater impact on Europe. Eurostat announced, based on preliminary estimates, that prices in the 21 member states of the eurozone rose by 3.8% year-on-year in September, reaching a three-year high, with energy product prices surging by 18.8% year-on-year in September. Rising inflation also prompted the ECB to raise interest rates in September. As interest rates rise, the increase in sovereign bond yields can be considered a direct market reaction.

This situation happens to U.S. Treasuries. Like European debt, long-term U.S. Treasury yields have remained high since October, with the yield on the 10-year U.S. Treasury climbing to a near 20-year high of 5.36%, and the 30-year Treasury yield reaching 5.73%. However, the results of the U.S. long-term Treasury auction on October 8 showed that at this level, demand for U.S. Treasuries was very robust. That day, the U.S. Department of the Treasury completed a USD 39 billion 10-year Treasury auction at a high yield of 5.3%. This auction yield was the highest since November 2000, yet it still attracted investors seeking stable long-term returns, causing the participation rate of large primary dealer banks acting as a backstop to drop to its lowest level since 2003, which precisely reflects the strength of genuine market demand.

This contrasts with the situation of European debt. Despite facing the same headwinds of high inflation, U.S. economic growth remains robust, and the status of the U.S. dollar remains strong, providing strong support for U.S. Treasuries. Europe, on the other hand, faces more severe stagflation pressures. Considering the geopolitical impacts of the conflicts in the Middle East and Russia-Ukraine, Europe faces a relatively weaker geo-financial situation, which has dragged down the euro and the sovereign credit of its member states. On October 8, the euro fell to 1.1185 against the U.S. dollar. The dollar has become the primary beneficiary of the euro's weakness, with the dollar index rising to 102.34, close to an 18-month high. The dollar remained generally stable against the Japanese yen at around 158.22, supported by potential intervention risks.

Compared with U.S. Treasuries, while both face massive government debt burdens and fiscal deficits, European debt still suffers from the structural flaws of the ECB, contrasting with the strength of the Federal Reserve and the resilience of the U.S. economic foundation. This situation is similar to the European debt crisis during the 2008 financial crisis, except that the main subject in the storm has shifted from Portugal, Italy, Greece, and Spain (“PIGS") to France, a core member of the European Union. Eurozone member states are currently still unable to formulate their own monetary policy and find it difficult to coordinate with their governments' fiscal policies the way the Fed does with the U.S. government. Although the ECB has established related bond-buying mechanisms, it still faces divisions among different member states, making it difficult to effectively constrain sovereign debt risks. Judging by the current situation, because France's fiscal deficit fails to meet relevant requirements, French government bonds are not supported by the ECB from a regulatory standpoint. Some institutions believe that the European Central Bank's Transmission Protection Instrument requires member states to comply with EU fiscal rules, and France currently does not meet the relevant conditions. If the French bond market faces further pressure due to fiscal or political risks, the policy buffer space the ECB can provide may be limited. With the central bank beginning to hike interest rates and shrink its balance sheet, France is unlikely to obtain support on the monetary policy front. This institutional flaw is the root cause of the inherent weakness of European debt credit and will likely be the source of greater volatility and crisis possibilities in this round of European debt fluctuations.

As it stands, the French government budget and deficit indeed carry the risk of spinning out of control amid economic deceleration. Media reports indicate that market concerns over the fiscal outlook of the eurozone's second-largest economy continue to mount, demanding a higher risk premium. Data from the French Treasury shows that as of the end of June 2026, the French central government fiscal deficit was approximately EUR 107 billion, 14.4% higher than the government budget plan. Forecast data updated by the French Treasury on September 19 shows that the fiscal deficit is expected to account for 5.4% of GDP in 2026, higher than the previous target of 5.0%, continually and substantially breaching the EU's 3% deficit red line. Market institutions calculate that if the social security system, local governments, and other generalized fiscal revenues and expenditures are included in the statistics, the total annual government deficit could reach approximately 8% of GDP. Of course, for France, economic sluggishness is also a major factor contributing to market concerns over its debt risk. France's growth forecast for 2026 has been downgraded three times, with the latest growth forecast standing at only 0.5%. Fitch has downgraded France's sovereign credit rating from AA− to A+, citing reasons including climbing debt burdens, escalating political uncertainty, and a lack of a credible path for fiscal consolidation.

As investors' concerns over France's public finances and policy execution capabilities grow, the yield on the 10-year French government bond has risen by more than 100 basis points this year, even surpassing the yield on Italian government bonds over the same period. Currently, the French government projects that public debt will reach 119.3% of GDP in 2026 and continue to climb to 121.7% in 2027. Total public debt has already surpassed 3.5 trillion euros. Within the eurozone, the only countries with public debt-to-GDP ratios higher than France are Greece and Italy, former PIGS nations, yet Italy's current government bond yield is now lower than France's. Although Italy's stock of government debt remains larger than France's, against the backdrop of debt reduction, Italy's fiscal deficit has already been constrained. Compared to the continuous growth of France's debt, Italy's sovereign credit is superior to that of France. For the bond market, this means that France's credit risk is being repriced. If French government bonds are affected, Italy, which has only recently escaped the troubles of debt, may likewise be dragged down, causing risks in the European debt market to spread continuously. Amid rising global interest rate levels, not only is the ECB shrinking its balance sheet, but Japan, a country that held European sovereign debt long-term during the low-interest-rate era, is also selling French government bonds and repatriating funds back to Japan. Currently, Japanese holdings of French debt have decreased by 2.5% compared to the end of last year. As Japanese interest rates continue to rise in the future, driving the repatriation of Japanese capital, the European debt market will bear the brunt of being sold off in a manner where everyone pushes a crumbling wall. Beyond affecting overseas investors, a larger problem for French government bonds stems from risks within European financial institutions. Banks across EU countries universally hold large amounts of domestic government bonds. Data shows that the scale of sovereign bonds held by eurozone banks is approximately EUR 1.9 trillion. French banks hold government bonds equivalent to about 2% of their total assets, but this accounts for roughly 60% of their capital. Falling bond prices and rising yields bring about unrealized losses and capital depletion for banks, and the contraction of banks will inevitably affect the real economy, which in turn impacts tax revenue and fiscal spending, forming an intensifying vicious cycle. As French government bonds plunged, bank stocks also experienced sharp declines, triggering a chain reaction in capital markets and leading to drops in major European stock markets.

Even if the situation is serious, the accumulation of risks has yet to reach the point of immediately triggering a financial crisis or a European debt crisis. Market concerns and fears mainly stem from political divisions in France and their implications for the country’s fiscal position and sovereign creditworthiness. The key issue is that, amid political fragmentation, the French government faces difficulties in effectively curbing public spending. Currently, French government spending accounts for about 57% of GDP, making it one of the countries with the highest welfare spending in the EU. Universal healthcare, pensions, unemployment benefits, public sector wages, and paid leave constitute a massive rigid foundation. Political fragmentation and intensifying social conflicts have weakened the capacity to advance fiscal reforms, turning deficit reduction into a mission impossible. This situation shares similarities with the current challenges facing the United States. The difference is that France has the EU above its sovereignty, making its political divisions even harder to heal. The fragmentation of the political landscape has resulted in the French government's fiscal budget repeatedly experiencing difficult deliveries, with no one willing to bear the consequences of offending voters. The rightward trend in French politics is becoming increasingly evident, and current President Emmanuel Macron is likely to be replaced. The uncertainty surrounding future political trajectories affects investor confidence, which in turn influences the pricing of sovereign debt. If Marine Le Pen is ultimately elected, given her policy proposals, fiscal policy divergences between the French government and the EU and the ECB could also intensify.

International Monetary Fund Managing Director Kristalina Georgieva recently issued a clear warning to the French government that it must control its finances and restrain borrowing. She stated that France's current plight stems from two aspects. On the one hand, the government has continuously borrowed while successively dealing with shocks, causing debt pressures to continuously accumulate. On the other hand, the complex political situation makes it more difficult for the fiscal department to chart a clear path of austerity. Although the fundamentals of French government bonds continue to deteriorate, what is truly causing credit risks to intensify is the shift in the political and financial landscape and situation. France's political fragmentation and rightward-leaning landscape mean that the conditions for bond vigilantes to detonate a new round of the European debt crisis continue to accumulate, and may even influence the political landscape of France and the EU alike.

Final analysis conclusion:

In this latest wave of global bond market sell-offs, credit risk associated with French government bonds has become more obvious. This reflects, on the one hand, the accumulation of long-standing economic and fiscal problems in France and, on the other, the impact of political divisions and uncertainty on financial markets. Given the structural weaknesses in the EU’s economic and fiscal framework and the European Central Bank’s institutional arrangements, the underlying vulnerabilities exposed by the eurozone debt crisis have not been fully resolved. Rather, they may simply re-emerge in a different form. The risk of a recurrence is also increasing as Europe’s geopolitical landscape continues to evolve.

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Dr. Wei Hongxu is a Senior Economist of China Macro-Economy Research Center at ANBOUND, an independent think tank.